XNYS:NSR NeuStar, Inc. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission file number 001-32548

 

 

NeuStar, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   52-2141938

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

21575 Ridgetop Circle

Sterling, Virginia 20166

(Address of principal executive offices) (zip code)

(571) 434-5400

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Small reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

There were 66,407,535 shares of Class A common stock, $0.001 par value, and 3,082 shares of Class B common stock, $0.001 par value, outstanding at July 20, 2012.

 

 

 


Table of Contents

NEUSTAR, INC.

INDEX

 

PART I FINANCIAL INFORMATION

     3   

Item 1.

  

Financial Statements

     3   
  

Consolidated Balance Sheets as of December 31, 2011 and June 30, 2012 (unaudited)

     3   
  

Unaudited Consolidated Statements of Operations for three and six months ended June 30, 2011 and 2012

     5   
  

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2012

     6   
  

Notes to Unaudited Consolidated Financial Statements

     7   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     24   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     35   

Item 4.

  

Controls and Procedures

     35   

PART II OTHER INFORMATION

     35   

Item 1.

  

Legal Proceedings

     35   

Item 1A.

  

Risk Factors

     35   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     36   

Item 3.

  

Defaults Upon Senior Securities

     36   

Item 4.

  

Mine Safety Disclosures

     36   

Item 5.

  

Other Information

     36   

Item 6.

  

Exhibits

     37   

Signatures

     

EX – 31.1

     

EX – 31.2

     

EX – 32.1

     

EX – 101 INSTANCE DOCUMENT

  

EX – 101 SCHEMA DOCUMENT

  

EX – 101 CALCULATION LINKBASE DOCUMENT

  

EX – 101 LABELS LINKBASE DOCUMENT

  

EX – 101 PRESENTATION LINKBASE DOCUMENT

  

EX – 101 DEFINITION LINBASE DOCUMENT

  


Table of Contents

PART I FINANCIAL INFORMATION

 

Item 1. Financial Statements

NEUSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

     December 31,
2011
     June 30,
2012
 
            (unaudited)  

ASSETS

  

Current assets:

     

Cash and cash equivalents

   $ 122,237      $ 224,635  

Restricted cash

     10,251        10,247  

Short-term investments

     10,545        10,381  

Accounts receivable, net of allowance for doubtful accounts of $1,942 and $2,952, respectively

     106,274        127,210  

Unbilled receivables

     5,551        8,439  

Notes receivable

     2,786        2,870  

Prepaid expenses and other current assets

     30,166        19,091  

Deferred costs

     8,174        7,764  

Income taxes receivable

     38,687        —     

Deferred tax assets

     6,264        7,738  
  

 

 

    

 

 

 

Total current assets

     340,935        418,375  

Long-term investments

     2,506        —     

Property and equipment, net

     100,102        108,651  

Goodwill

     573,307        573,307  

Intangible assets, net

     338,768        313,625  

Notes receivable, long-term

     3,748        2,291  

Deferred costs, long-term

     701        831  

Other assets, long-term

     22,767        20,942  
  

 

 

    

 

 

 

Total assets

   $ 1,382,834      $ 1,438,022  
  

 

 

    

 

 

 

See accompanying notes.

 

3


Table of Contents

NEUSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

     December 31,
2011
    June 30,
2012
 
           (unaudited)  

LIABILITIES AND STOCKHOLDERS’ EQUITY

  

 

Current liabilities:

    

Accounts payable

   $ 7,385     $ 3,569  

Accrued expenses

     79,334       61,156  

Income taxes payable

     —          6,126  

Deferred revenue

     41,080       47,597  

Note payable

     4,856       59,336  

Capital lease obligations

     3,065       3,094  

Accrued restructuring reserve

     4,361       1,287  

Other liabilities

     5,317       3,660  
  

 

 

   

 

 

 

Total current liabilities

     145,398       185,825  

Deferred revenue, long-term

     10,363       10,392  

Note payable, long-term

     584,809       527,892  

Capital lease obligations, long-term

     1,918       1,011  

Deferred tax liability, long-term

     121,237       120,222  

Other liabilities, long-term

     16,475       18,375  
  

 

 

   

 

 

 

Total liabilities

     880,200       863,717  

Commitments and contingencies

     —          —     

Stockholders’ equity:

    

Preferred stock, $0.001 par value; 100,000,000 shares authorized; no shares issued and outstanding as of December 31, 2011 and June 30, 2012

     —          —     

Class A common stock, par value $0.001; 200,000,000 shares authorized; 82,959,411 and 85,117,381 shares issued and outstanding at December 31, 2011 and June 30, 2012, respectively

     83       85  

Class B common stock, par value $0.001; 100,000,000 shares authorized; 3,082 and 3,082 shares issued and outstanding at December 31, 2011 and June 30, 2012, respectively

     —          —     

Additional paid-in capital

     436,598       493,790  

Treasury stock, 16,807,932 and 18,473,005 shares at December 31, 2011 and June 30, 2012, respectively, at cost

     (495,790     (553,909

Accumulated other comprehensive loss

     (758     (716

Retained earnings

     562,501       635,055  
  

 

 

   

 

 

 

Total stockholders’ equity

     502,634       574,305  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,382,834     $ 1,438,022  
  

 

 

   

 

 

 

 

See accompanying notes.

 

4


Table of Contents

NEUSTAR, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2012     2011     2012  

Revenue:

        

Carrier Services

   $ 110,834     $ 126,347     $ 220,449     $ 250,720  

Enterprise Services

     36,849       42,089       73,329       81,574  

Information Services

     —          38,026       —          73,750  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     147,683       206,462       293,778       406,044  

Operating expense:

        

Cost of revenue (excluding depreciation and amortization shown separately below)

     31,417       46,127       62,469       91,025  

Sales and marketing

     26,267       41,073       51,206       79,426  

Research and development

     3,441       8,096       7,437       15,820  

General and administrative

     21,949       20,091       42,164       41,084  

Depreciation and amortization

     9,386       22,713       18,532       45,419  

Restructuring (recoveries) charges

     (12     2       420       524  
  

 

 

   

 

 

   

 

 

   

 

 

 
     92,448       138,102       182,228       273,298  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     55,235       68,360       111,550       132,746  

Other (expense) income:

        

Interest and other expense

     (126     (8,404     (473     (16,597

Interest and other income

     930       110       1,133       339  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     56,039       60,066       112,210       116,488  

Provision for income taxes, continuing operations

     22,423       21,474       45,129       43,934  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     33,616       38,592       67,081       72,554  

(Loss) income from discontinued operations, net of tax

     (1,261     —          37,249       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 32,355     $ 38,592     $ 104,330     $ 72,554  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per common share:

        

Continuing operations

   $ 0.46     $ 0.58     $ 0.91     $ 1.08  

Discontinued operations

     (0.02     —          0.50       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per common share

   $ 0.44     $ 0.58     $ 1.41     $ 1.08  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per common share:

        

Continuing operations

   $ 0.45     $ 0.57     $ 0.89     $ 1.06  

Discontinued operations

     (0.02     —          0.50       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per common share

   $ 0.43     $ 0.57     $ 1.39     $ 1.06  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding:

        

Basic

     73,807       66,917       73,872       67,060  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     75,015       67,887       75,129       68,132  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 31,923     $ 38,853     $ 103,984     $ 72,596  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

5


Table of Contents

NEUSTAR, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Six Months Ended
June 30,
 
     2011     2012  

Operating activities:

    

Net income

   $ 104,330     $ 72,554  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     19,161       45,419  

Stock-based compensation

     12,612       10,950  

Amortization of deferred financing costs and original discount on debt

     85       1,974  

Excess tax benefits from stock option exercises

     (3,279     (8,123

Deferred income taxes

     (632     (2,218

Provision for doubtful accounts

     1,544       1,881  

Gain on available-for-sale investments

     (673     —     

Amortization of investment premium (discount), net

     1,607       282  

Loss on asset sale

     1,933       —     

Changes in operating assets and liabilities, net of acquisitions:

    

Accounts receivable

     (995     (23,401

Unbilled receivables

     6,402       (2,888

Notes receivable

     (6,276     1,373  

Prepaid expenses and other current assets

     1,101       11,158  

Deferred costs

     (650     280  

Income taxes receivable

     (15,874     46,811   

Other assets

     316       515  

Other liabilities

     (2,071     (1,857

Accounts payable and accrued expenses

     (3,005     (22,720

Income taxes payable

     1,689       6,126   

Accrued restructuring reserve

     (2,221     (3,074

Deferred revenue

     (1,221     6,545  
  

 

 

   

 

 

 

Net cash provided by operating activities

     113,883       141,587  

Investing activities:

    

Purchases of property and equipment

     (24,954     (24,484

Sales and maturities of investments

     33,284       2,380  

Purchases of investments

     (71,031     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (62,701     (22,104

Financing activities:

    

(Increase) decrease in restricted cash

     (8,927     4  

Principal repayments on note payable

     —          (3,000

Principal repayments on capital lease obligations

     (4,510     (1,892

Proceeds from exercise of common stock options

     10,506       38,131  

Excess tax benefits from stock-based compensation

     3,279       8,123  

Repurchase of restricted stock awards

     (1,305     (9,301

Repurchase of common stock

     (36,683     (48,818
  

 

 

   

 

 

 

Net cash used in financing activities

     (37,640     (16,753

Effect of foreign exchange rates on cash and cash equivalents

     (114     (332
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     13,428       102,398  

Cash and cash equivalents at beginning of period

     331,570       122,237  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 344,998     $ 224,635  
  

 

 

   

 

 

 

See accompanying notes.

 

6


Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

1. DESCRIPTION OF BUSINESS AND ORGANIZATION

NeuStar, Inc. (the Company or Neustar) is a trusted, neutral provider of real-time information and analysis to the Internet, telecommunications, entertainment, and marketing industries. Using the Company’s advanced, secure technologies, the Company provides addressing, routing, policy management and authentication services that enable its customers to find their end users, route network traffic to the optimal location and verify end-user identity. The Company provides services to both communications service providers, or carriers, and commercial businesses, or enterprises. With the Company’s expertise in database management and analysis, the Company also provides cyber security and marketing information and analysis to its customers.

The Company was incorporated as a Delaware corporation in 1998. The Company was founded to meet the technical and operational challenges of the communications industry when the U.S. government mandated local number portability in 1996. The Company provides the authoritative solution that the communications industry relies upon to meet this mandate. Since then, the Company has grown to offer a broad range of innovative services, including registry services, managed domain name system (DNS) services, Internet Protocol (IP) services, fixed IP geolocation services, Internet security services, caller identification (Caller ID) services, web performance monitoring services, and real-time information and analytics services.

The Company operates in three segments:

 

   

Carrier Services. The Company’s carrier services include numbering services, order management services and IP services. Through its set of unique databases and system infrastructure in geographically dispersed data centers, the Company manages the increasing complexity in the communications industry and ensures the seamless connection of its carrier customers’ numerous networks, while also enhancing the capabilities and performance of their infrastructure. The Company operates the authoritative databases that manage virtually all telephone area codes and numbers, and enables the dynamic routing of calls and text messages among numerous competing carriers in the United States and Canada. All carriers that offer telecommunications services to the public at large in the United States and Canada must access a copy of the Company’s unique database to properly route their customers’ calls and text messages. The Company also facilitates order management and work-flow processing among carriers, and allows operators to manage and optimize the addressing and routing of IP communications.

 

   

Enterprise Services. The Company’s enterprise services include Internet infrastructure services (IIS) and registry services. Through the Company’s global directory platform, the Company provides a suite of DNS services to its enterprise customers. The Company manages a collection of directories that maintain addresses in order to direct, prioritize and manage Internet traffic, and to find and resolve Internet queries and top-level domains. The Company is the authoritative provider of essential registry services and manages directories of similar resources, or addresses, that its customers use for reliable, fair and secure access and connectivity. In addition, enterprise customers rely on the Company’s services to monitor and load-test websites to help identify issues and optimize performance. The Company also provides fixed IP geolocation services that help enterprises identify the location of their online consumers for a variety of purposes, including fraud prevention and marketing. Additionally, the Company provides directory services for the 5- and 6-digit number strings used for all U.S. Common Short Codes, which is part of the short messaging service relied upon by the U.S. wireless industry. In addition, the Company operates the digital content authentication directory, which supports the UltraVioletTM digital content locker by which consumers can gain access to their entertainment content.

 

   

Information Services. The Company’s information services include on-demand solutions that help carriers and enterprises identify, verify, score and locate customers and prospective customers. The Company’s authoritative databases and solutions enable its clients to return the caller name associated with the calling phone number and to make informed decisions in real time about consumer-initiated interactions on the Internet, over the telephone and at the point of sale, by correlating consumer identifier information with attributes such as demographics, buying behaviors and location. This allows the Company’s customers to offer consumers more relevant services and products, and leads to higher client conversion rates. Using the Company’s proprietary databases, the Company’s online display advertising solution allows marketers to display, in real time, advertisements that will be most relevant to online consumers without the need for online behavioral tracking.

 

7


Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the full fiscal year. The consolidated balance sheet as of December 31, 2011 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the 2011 Form 10-K) filed with the Securities and Exchange Commission (SEC).

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting periods. Significant estimates and assumptions are inherent in the analysis and the measurement of deferred tax assets; the identification and quantification of income tax liabilities due to uncertain tax positions; restructuring liabilities; valuation of investments; recoverability of intangible assets, other long-lived assets and goodwill; the determination of the allowance for doubtful accounts; and the classification of note payable. The Company bases its estimates on historical experience and assumptions that it believes are reasonable. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic Financial Instruments requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. Due to their short-term nature, the carrying amounts reported in the accompanying unaudited consolidated financial statements approximate the fair value for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses. The Company determines the fair value of its investments using third–party pricing sources, which primarily use a consensus price or weighted average price for the fair value assessment. The consensus price is determined by using matrix prices from a variety of industry standard pricing services, data providers, large financial institutions and other third party sources and utilizing those matrix prices as inputs into a distribution-curve-based algorithm to determine the estimated market value. Matrix prices are based on quoted prices for securities with similar terms (i.e., coupon rate, maturity, credit rating) (see Note 5). The Company believes the carrying value of its notes receivable approximates fair value as the interest rate approximates a market rate. The Company believes the carrying value of its long-term debt approximates the fair value of the debt as the terms and interest rates approximate market rates.

The estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

     December 31, 2011      June 30, 2012  
     Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  

Cash and cash equivalents

   $ 122,237      $ 122,237      $ 224,635      $ 224,635  

Restricted cash (current assets)

   $ 10,251      $ 10,251      $ 10,247      $ 10,247  

Short-term investments

   $ 10,545      $ 10,545      $ 10,381      $ 10,381  

Notes receivable (including current portion)

   $ 6,534      $ 6,534      $ 5,161      $ 5,161  

Marketable securities (other assets, long-term)

   $ 4,008      $ 4,008      $ 4,260      $ 4,260  

Long-term investments

   $ 2,506      $ 2,506      $ —         $ —     

Deferred compensation (other liabilities, long-term)

   $ 4,028      $ 4,028      $ 3,828      $ 3,828  

Note payable (including current portion)

   $ 589,665      $ 589,665      $ 587,228      $ 587,228  

 

8


Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Restricted Cash

As of December 31, 2011 and June 30, 2012, restricted cash was $10.3 million and $10.2 million, respectively. As of December 31, 2011 and June 30, 2012, cash of $9.2 million and $9.1 million was restricted as collateral for the Company’s outstanding letters of credit, respectively. As of both December 31, 2011 and June 30, 2012, cash of $1.1 million was restricted for deposits on leased facilities.

Recent Accounting Pronouncements

In June 2011, the FASB issued Auditing Standard Update 2011-05, Presentation of Comprehensive Income (ASU 2011-05), to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. The amendments to this standard require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in ASU 2011-05, which defers the effective date of only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The adoption of the amended accounting guidance impacted the Company’s presentation of other comprehensive income and did not have an impact on the Company’s consolidated results of operations.

3. ACQUISITIONS

The application of the acquisition method of accounting for business combinations requires management to make significant estimates and assumptions in the determination of the fair value of the assets acquired and liabilities assumed in order to properly allocate purchase price consideration. These assumptions and estimates include a market participant’s expected use of the asset and the appropriate discount rates from a market participant perspective. The Company’s estimates are based on historical experience and information obtained from the management of the acquired company and are determined with assistance from an independent third-party appraisal firm. The Company’s significant assumptions and estimates include the cash flows that an acquired asset is expected to generate in the future, the weighted-average cost of capital, long-term projected revenue and growth rates, and the estimated royalty rate in the application of the relief from royalty method.

Evolving System Inc. Number Solutions Acquisition

On July 1, 2011, the Company acquired the assets and certain liabilities of the Numbering Solutions business of Evolving Systems, Inc. for cash consideration of $39.0 million. The acquisition of Evolving Systems’ Numbering Solutions business expanded the Company’s Order Management Services portfolio and furthered the Company’s long-term initiative to simplify operators’ Operations Support Systems architectures by mitigating cost and complexity, while making the evolution to next-generation networks more efficient, manageable, and flexible to meet the increasingly complex needs of end-users.

The transaction was accounted for under the acquisition method of accounting in accordance with the Business Combinations Topic of the FASB ASC and the results of operations have been included within the Carrier Services segment in the Company’s consolidated statement of operations since the date of acquisition. Of the total purchase price, the Company recorded $20.3 million of goodwill, $21.7 million of definite-lived intangible assets, and $3.0 million of net liabilities. The definite-lived intangible assets consist of $18.9 million of customer relationships and $2.8 million of acquired technology. The Company is amortizing customer relationships and acquired technology on a straight-line basis over an estimated useful life of 10 years and 5 years, respectively. The total amount of goodwill that is expected to be deductible for tax purposes is $19.7 million.

TARGUSinfo Acquisition

On November 8, 2011, the Company completed its acquisition of Targus Information Corporation (TARGUSinfo), a leading, independent provider of real-time, on-demand information and analytics services including Caller ID.

The acquisition of TARGUSinfo significantly extends the Company’s portfolio of services in the real-time information and analytics market and combines TARGUSinfo’s leadership in Caller ID and online information services, such as lead verification and scoring, with the Company’s strengths in network information services, including address inventory management and network security. These services are delivered through a secure, robust technology platform, and rely on unique, extensive and privacy-protected databases.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

The transaction was accounted for under the acquisition method of accounting in accordance with the Business Combinations Topic of the FASB ASC and the results of operations have been included within the Information Services segment in the Company’s consolidated statement of operations since the date of acquisition.

The total purchase price was approximately $657.5 million, consisting of cash consideration of $656.8 million and non-cash consideration of $0.7 million attributable to the assumption of TARGUSinfo options. Of the total cash consideration, approximately $43.5 million was deposited in an escrow account, of which $40.0 million is available to satisfy indemnification claims for breaches of the agreement and plan of merger. An additional $3.0 million and $0.5 million of the merger consideration payable to the stockholders of TARGUSinfo was deposited into separate escrow accounts and was available to fund purchase price adjustments required under the merger agreement and to reimburse certain costs and expenses of the stockholder representative, respectively. As of June 30, 2012, the remaining escrow to satisfy indemnification claims and to reimburse certain costs and expenses of the stockholder representative were $39.4 million and $0.5 million, respectively. During the three months ended March 31, 2012, the purchase price escrow of $3.0 million was distributed and such distribution did not result in an adjustment to the purchase price or goodwill. As of June 30, 2012, outstanding escrow claims of $0.5 million reduced the Company’s original purchase price as further discussed below. The funds in the indemnity escrow account will remain in escrow for a one-year period from the date of acquisition (unless claims are pending at such time), after which remaining proceeds will be distributed to the TARGUSinfo stockholders.

Under the acquisition method of accounting, the total estimated purchase price was allocated to TARGUSinfo’s net tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of November 8, 2011. Of the total purchase price, the Company recorded the preliminary fair value of net tangible and intangible assets acquired and liabilities assumed of approximately $429.7 million of goodwill, $310.2 million of definite-lived intangible assets, and $81.9 million of net liabilities. During the three months ended June 30, 2012, the Company adjusted its preliminary valuation of acquired assets and liabilities assumed based upon new information that was received pertaining to acquisition date fair values. The adjustments related to finalizing the assessment of federal research and development tax credits and the resolution of certain state and local tax liabilities, each pertaining to pre-acquisition tax periods. The consolidated balance sheet as of December 31, 2011 has been retrospectively adjusted to include the effect of the measurement period adjustments (see Note 6). The allocation of the purchase price is preliminary pending the finalization of additional income and non-income based tax liabilities. The Company does not expect the finalization of these items to materially impact the purchase price allocation.

The following table summarizes the preliminary purchase price allocation based on the estimated fair value of the acquired assets and assumed liabilities based on their fair values as of the acquisition date and the effects of the measurement period adjustments recorded in the second quarter of 2012 (in thousands), as discussed above:

 

Cash and cash equivalents

   $ 1,601  

Accounts receivable

     23,844  

Income tax receivable

     15,351  

Other assets

     14,406  

Accounts payable and accrued expenses

     (9,689

Deferred tax liability

     (119,012

Deferred revenue

     (3,604

Other liabilities

     (3,926
  

 

 

 

Net tangible liabilities assumed

     (81,029

Customer relationships

     256,700  

Acquired identified technology

     46,500  

Trade names and trademarks

     7,000  

Goodwill

     428,356  
  

 

 

 

Total purchase price allocation

   $ 657,527  
  

 

 

 

Of the total purchase price, the Company recorded $428.4 million of goodwill, $310.2 million of definite-lived intangible assets, and $81.0 million of net liabilities. The definite-lived intangible assets consist of $256.7 million of customer relationships, $46.5 million of acquired technology, and $7.0 million of trade names and trademarks. The value of customer relationships, acquired technology and trade names and trademarks will be amortized on a straight-line basis over their estimated useful life of 8 years, 5 years and 3 years, respectively. The goodwill balance of $428.4 million is not expected to be deductible for tax purposes.

As a result of the acquisition of TARGUSinfo, the Company recorded a net deferred tax liability of approximately $116.2 million in its preliminary purchase price allocation primarily related to the difference in book and tax basis of identifiable intangibles. As of

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

June 30, 2012, the net deferred tax liability was $106.0 million. The Company also recorded a $14.3 million income tax receivable assumed from TARGUSinfo as a result of the acquisition and accrued $1.2 million for potential sales tax and interest due on TARGUSinfo sales for prior years through 2010. As of June 30, 2012, the income tax receivable assumed from TARGUSinfo was $15.4 million and the accrued potential sales tax and interest due on TARGUSinfo sales for prior years through 2010 was $1.2 million.

Pro Forma Financial Information for acquisition of TARGUSinfo

The following unaudited pro forma financial information summarizes the Company’s results of operations for the three and six months ended June 30, 2011 as if Neustar’s acquisition of TARGUSinfo had been completed as of January 1, 2011. These pro forma amounts (unaudited and in thousands) do not purport to be indicative of the results that would have actually been obtained if the acquisition occurred as of January 1, 2011 and should not be construed as representative of the future consolidated results of operations or financial condition of the combined entity. The pro forma financial information presented also includes the effect of the related financing, amortization expense from acquired intangible assets, adjustments to interest expense and related tax effects.

 

     Three Months
Ended
June 30, 2011
     Six Months
Ended
June 30, 2011
 

Pro forma revenue

   $ 187,914      $ 368,354  
  

 

 

    

 

 

 

Pro forma income from operations

   $ 64,602       $ 123,904  
  

 

 

    

 

 

 

Pro forma net income

   $ 34,015      $ 64,307  
  

 

 

    

 

 

 

4. INVESTMENTS

As of December 31, 2011 and June 30, 2012, the Company held approximately $13.1 million and $10.4 million, respectively, in pre-refunded municipal bonds, secured by an escrow fund of U.S. Treasury securities. These investments are accounted for as available-for-sale securities in the Company’s consolidated balance sheet pursuant to the Investments -Debt and Equity Securities Topic of the FASB ASC. During the three and six months ended June 30, 2011, the Company sold approximately $33.0 million and $33.3 million, respectively, of available-for-sale securities and recognized realized gains of $0.1 million and $0.1 million, respectively. During the three and six months ended June 30, 2012, the Company sold approximately $1.0 million and $2.4 million, respectively, of available-for-sale securities and recognized minimal net gains for both periods. The Company did not record any impairment charges related to these investments during the six months ended June 30, 2011 and 2012. The following table summarizes the Company’s investment in these pre-refunded municipal bonds as of December 31, 2011 and June 30, 2012 (in thousands):

 

     December 31, 2011  
     Amortized
Cost
     Gross Unrealized     Estimated
Fair  Value
 
        Gains      Losses    

Due within one year

   $ 10,538      $ 10      $ (3   $ 10,545  

Due after one year through three years

     2,500        6        —          2,506  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 13,038      $ 16      $ (3   $ 13,051  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     June 30, 2012  
     Amortized
Cost
     Gross Unrealized     Estimated
Fair  Value
 
        Gains      Losses    

Due within one year

   $ 10,376      $ 6      $ (1   $ 10,381  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

5. FAIR VALUE MEASUREMENTS

Fair value is the price that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Fair Value Measurements and Disclosure Topic of FASB ASC establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value and requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

 

   

Level 1. Observable inputs, such as quoted prices in active markets;

 

   

Level 2. Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and

 

   

Level 3. Unobservable inputs for which there is little or no market data, which require the reporting entity to develop its own assumptions.

The Company evaluates assets and liabilities subject to fair value measurements on a recurring and non-recurring basis to determine the appropriate level at which to classify them for each reporting period. This determination requires the Company to make significant judgments.

The Company determines the fair value of its investments using third–party pricing sources, which primarily use a consensus price or weighted average price for the fair value assessment. The consensus price is determined by using matrix prices from a variety of industry standard pricing services, data providers, large financial institutions and other third party sources and utilizing those matrix prices as inputs into a distribution-curve-based algorithm to determine the estimated market value. Matrix prices are based on quoted prices for securities with similar terms (i.e., coupon rate, maturity, credit rating). The Company corroborates consensus prices provided by third party pricing sources using reported trade activity, benchmark yield curves, binding broker/dealer quotes or other relevant price information.

The following table sets forth, as of December 31, 2011 and June 30, 2012, the Company’s financial and non-financial assets and liabilities that are measured at fair value on a recurring basis, by level within the fair value hierarchy (in thousands):

 

     December 31, 2011  
     Level 1      Level 2      Level 3      Total  

Municipal bonds (maturities less than one year)

   $ —         $ 10,545      $ —         $ 10,545  

Municipal bonds (maturities one to three years)

   $ —         $ 2,506      $ —         $ 2,506  

Marketable securities(1)

   $ 4,008      $ —         $ —         $ 4,008  
           

 

     June 30, 2012  
     Level 1      Level 2      Level 3      Total  

Municipal bonds (maturities less than one year)

   $ —         $ 10,381      $ —         $ 10,381  

Marketable securities(1)

   $ 4,260      $ —         $ —         $ 4,260  

 

(1) The NeuStar, Inc. Deferred Compensation Plan (the Plan) provides directors and certain employees with the ability to defer a portion of their compensation. The assets of the Plan are invested in marketable securities held in a Rabbi Trust and reported at market value in other assets.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

6. GOODWILL AND INTANGIBLE ASSETS

Goodwill

During the three months ended June 30, 2012, the Company adjusted its preliminary valuation of acquired assets and liabilities assumed based upon new information that was received pertaining to acquisition date fair values (see Note 3). The following table shows the retrospective adjustments made to the balance of goodwill as of December 31, 2011 to reflect the effect of these measurement period adjustments. The Company’s goodwill by operating segment as of December 31, 2011 and June 30, 2012 is as follows (in thousands):

 

     December 31,
2011  (1)
    Adjustments     June 30,
2012
 

Carrier Services:

      

Gross goodwill

   $ 222,355      $ —        $ 222,355  

Accumulated impairment losses

     (93,602 )       —          (93,602
  

 

 

   

 

 

   

 

 

 

Net goodwill

     128,753        —          128,753  
  

 

 

   

 

 

   

 

 

 

Enterprise Services:

      

Gross goodwill

     16,198        —          16,198  

Accumulated impairment losses

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net goodwill

     16,198        —          16,198  
  

 

 

   

 

 

   

 

 

 

Information Services:

      

Gross goodwill

     429,700        (1,344     428,356  

Accumulated impairment losses

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net goodwill

     429,700        (1,344     428,356  
  

 

 

   

 

 

   

 

 

 

Total:

      

Gross goodwill

     668,253        (1,344     666,909  

Accumulated impairment losses

     (93,602 )       —          (93,602
  

 

 

   

 

 

   

 

 

 

Net goodwill

   $ 574,651      $ (1,344   $ 573,307  
  

 

 

   

 

 

   

 

 

 

 

(1) Balance as originally reported at December 31, 2011 prior to the reflection of measurement period adjustments.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Intangible Assets

Intangible assets consist of the following (in thousands):

 

     December 31,
2011
    June 30,
2012
    Weighted-
Average
Amortization
Period

(in years)

Intangible assets:

      

Customer lists and relationships

   $ 315,098     $ 315,098     7.9

Accumulated amortization

     (32,615     (51,074  
  

 

 

   

 

 

   

Customer lists and relationships, net

     282,483       264,024    
  

 

 

   

 

 

   

Acquired technology

     58,859       58,859     4.8

Accumulated amortization

     (9,493     (14,940  
  

 

 

   

 

 

   

Acquired technology, net

     49,366       43,919    
  

 

 

   

 

 

   

Trade name

     7,630       7,630     3.0

Accumulated amortization

     (711     (1,948  
  

 

 

   

 

 

   

Trade name, net

     6,919       5,682    
  

 

 

   

 

 

   

Intangible assets, net

   $ 338,768     $ 313,625    
  

 

 

   

 

 

   

Amortization expense related to intangible assets, which is included in depreciation and amortization expense, was approximately $1.1 million and $12.5 million for the three months ended June 30, 2011 and 2012, respectively, and $2.2 million and $25.1 million for the six months ended June 30, 2011 and 2012, respectively. Amortization expense related to intangible assets for the years ended December 31, 2012, 2013, 2014, 2015, 2016 and thereafter is expected to be approximately $50.3 million, $48.9 million, $47.9 million, $45.9 million, $44.1 million and $101.7 million, respectively. Intangible assets as of June 30, 2012 will be fully amortized during the year ended December 31, 2021.

7. NOTE PAYABLE

On November 8, 2011, the Company entered into a credit facility that provides for: (1) a $600 million senior secured term loan facility (Term Facility); (2) a $100 million senior secured revolving credit facility (Revolving Facility and together with the Term Facility, the 2011 Facilities), of which (a) $30 million is available for the issuance of letters of credit and (b) $25 million is available as a swingline subfacility; and (3) incremental term loan facilities in an aggregate amount of up to $400 million. The Revolving Facility matures on November 8, 2016, and the Term Facility matures on November 8, 2018. The entire $600 million Term Facility was borrowed on November 8, 2011, and used to fund a portion of the acquisition of TARGUSinfo and to pay costs, fees and expenses incurred in connection with the acquisition. The Company has not borrowed under the Revolving Facility.

The 2011 Facilities contain customary representations and warranties, affirmative and negative covenants, and events of default. If an event of default occurs and so long as such event of default is continuing, the amounts outstanding may accrue interest at an increased rate and payments of such outstanding amounts could be accelerated, or other remedies undertaken pursuant to the 2011 Facilities. The Company’s quarterly financial covenants include a maximum consolidated fixed charge coverage ratio and a minimum consolidated leverage ratio. As of and for the six months ended June 30, 2012, the Company was in compliance with these covenants.

Principal payments under the Term Facility of $1.5 million are due on the last day of the quarter starting on December 31, 2011 and ending on September 30, 2018. The remaining Term Facility principal balance of $558.0 million is due in full on November 8, 2018, subject to early mandatory prepayments as further discussed below. As of December 31, 2011 and June 30, 2012, the annual interest rate on the Term Facility was 5%.

The Company paid $10.0 million of loan origination fees related to its 2011 Facilities and recorded $19.4 million in deferred financing costs. Total amortization expense of the loan origination fees and deferred financing costs was approximately $1.0 million and $2.0 million for the three and six months ended June 30, 2012, respectively, and is reported as interest expense in the consolidated statements of operations.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

The Term Facility has a 1% prepayment fee in the event it is refinanced within the first year of issuance. The 2011 Facilities provide for mandatory prepayments with the net cash proceeds of certain debt issuances, equity issuances, insurance receipts, dispositions and excess cash flows. Mandatory prepayments attributable to excess cash flows will be based on the Company’s leverage ratio and will be determined at the end of each fiscal year, beginning with the year ended December 31, 2012. A leverage ratio of 1.5x or higher will trigger mandatory prepayments of 25% or 50% of excess cash flow. As of June 30, 2012, the Company estimated a mandatory prepayment of approximately $54.5 million to be payable in the first quarter of 2013 and reclassified this estimated prepayment amount from long-term note payable to current note payable in the Company’s accompanying unaudited consolidated balance sheets.

As of December 31, 2011 and June 30, 2012, the Company’s outstanding borrowings under the Term Facility were $589.7 million and $587.2 million, respectively, and accrued interest under the 2011 Facilities was $4.5 million and $0.2 million, respectively. As of December 31, 2011 and June 30, 2012, the Company’s available borrowings under the Revolving Facility were $100 million.

8. STOCKHOLDERS’ EQUITY

Stock-Based Compensation

The Company has five stock incentive plans: the NeuStar, Inc. 1999 Equity Incentive Plan (1999 Plan); the NeuStar, Inc. 2005 Stock Incentive Plan (2005 Plan); the NeuStar, Inc. 2009 Stock Incentive Plan (2009 Plan); the Targus Information Corporation Amended and Restated 2004 Stock Incentive Plan (TARGUSinfo Plan); and the AMACAI Information Corporation 2004 Stock Incentive Plan (AMACAI Plan) (collectively, the Plans). The Company may grant to its directors, employees and consultants awards under the 2009 Plan in the form of incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted stock, restricted stock units, performance vested restricted stock units (PVRSUs) and other stock-based awards. The aggregate number of shares of Class A common stock with respect to which all awards may be granted under the 2009 Plan is 11,911,646, plus the number of shares underlying awards granted under the 1999 Plan, the 2005 Plan, the TARGUSinfo Plan, and the AMACAI Plan that remain undelivered following any expiration, cancellation or forfeiture of such awards. As of June 30, 2012, 2,280,211 shares were available for grant or award under the 2009 Plan. An additional 3,000,000 shares, approved by the Company’s stockholders at the June 20, 2012 annual meeting of stockholders, will become available for grant once registered on a Form S-8 filed with the SEC.

On June 20, 2012, at the Company’s annual shareholder meeting, stockholders approved the NeuStar, Inc. Employee Stock Purchase Plan (ESPP). The Company anticipates the ESPP will be made available to its employees in the second quarter of 2013, following the registration of the 600,000 shares available under the ESPP on a Form S-8 filed with the SEC.

Stock-based compensation expense recognized for the three months ended June 30, 2011 and 2012 was $6.0 million and $7.0 million, respectively, and $12.0 million and $11.0 million for the six months ended June 30, 2011 and 2012, respectively. As of June 30, 2012, total unrecognized compensation expense related to non-vested stock options, non-vested restricted stock awards, non-vested restricted stock units and non-vested PVRSUs granted prior to that date was estimated at $58.6 million, which the Company expects to recognize over a weighted average period of approximately 1.92 years. Total unrecognized compensation expense as of June 30, 2012 is estimated based on outstanding non-vested stock options, non-vested restricted stock awards, non-vested restricted stock units and non-vested PVRSUs. Stock-based compensation expense may increase or decrease in future periods for subsequent grants or forfeitures, and changes in the estimated fair value of non-vested awards granted to consultants.

Stock Options

The Company utilizes the Black-Scholes option pricing model to estimate the fair value of stock options granted. The weighted-average grant date fair value of options granted during the three and six months ended June 30, 2011 was $8.86 and $8.72, respectively. No options were granted during the six months ended June 30, 2012. The following are the weighted-average assumptions used in valuing the stock options granted during the three and six months ended June 30, 2011:

 

     Three Months
Ended
June 30, 2011
    Six Months Ended
June 30, 2011
 

Dividend yield

     —       —  

Expected volatility

     36.50     36.93

Risk-free interest rate

     1.88     1.72

Expected life of options (in years)

     4.42       4.42  

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

The following table summarizes the Company’s stock option activity:

 

     Shares     Weighted-
Average
Exercise
Price
     Aggregate
Intrinsic
Value

(in  millions)
     Weighted-
Average
Remaining
Contractual
Life

(in years)
 

Outstanding at December 31, 2011

     6,533,826     $ 24.15        

Options granted

     —          —           

Options exercised

     (1,670,588     22.83        

Options forfeited

     (619,297     22.34        
  

 

 

         

Outstanding at June 30, 2012

     4,243,941     $ 24.93      $ 35.9        7.3  
  

 

 

         

Exercisable at June 30, 2012

     1,815,730     $ 24.77      $ 15.7        6.2  
  

 

 

         

The aggregate intrinsic value of options exercised for the six months ended June 30, 2011 and 2012 was $19.2 million and $20.7 million, respectively.

Restricted Stock Awards

The following table summarizes the Company’s non-vested restricted stock activity for the six months ended June 30, 2012:

 

     Shares     Weighted-
Average
Grant Date
Fair Value
     Aggregate
Intrinsic
Value

(in  millions)
 

Outstanding at December 31, 2011

     644,995     $ 24.16     

Restricted stock granted

     —          —        

Restricted stock vested

     (154,560     23.46     

Restricted stock forfeited

     (95,649     24.16     
  

 

 

      

Outstanding at June 30, 2012

     394,786     $ 24.43      $ 13.2  
  

 

 

      

The total aggregate intrinsic value of restricted stock vested during the six months ended June 30, 2012 was approximately $5.4 million. During the three and six months ended June 30, 2012, the Company repurchased 9,577 and 57,367 shares of common stock, respectively, for an aggregate purchase price of $0.3 million and $2.0 million, respectively, pursuant to the participants’ rights under the Company’s stock incentive plans to elect to use common stock to satisfy their tax withholding obligations.

Performance Vested Restricted Stock Units

During the six months ended June 30, 2012, the Company awarded 2,213,780 PVRSUs, of which 601,715 PVRSUs were granted with an aggregate fair value of $21.9 million. For executive management, the awarded PVRSUs are subject to five one-year performance periods, the first of which begins on January 1, 2012 and ends December 31, 2012 and the last of which begins on January 1, 2016 and ends on December 31, 2016. Each executive is eligible to earn up to 150% of one-fifth of the award with respect to each annual performance period subject to the achievement of the respective performance goals for each one-year performance period. For non-executive management, the PVRSUs awarded are subject to three one-year performance periods, the first of which begins on January 1, 2012 and ends December 31, 2012 and the last of which begins on January 1, 2014 and ends on December 31, 2014. Each non-executive is eligible to earn up to 150% of one-third of the award with respect to each annual performance period subject to the achievement of the respective performance goals for each one-year performance period. For both executive and non-executive management, the performance goal for the performance period from January 1, 2012 through December 31, 2012 will be based on: (i) Non-NPAC Revenue, (ii) Total Revenue, and (iii) Adjusted Net Income. The performance goals for the future one-year performance periods will consist of financial measures, weights and payouts to be established no later than 90 days after the beginning of each such period.

Subject to each participant’s continued service and to certain other terms and conditions, the portion of the award, if any, earned (a) by executive management with respect to the first three performance periods will vest on January 1, 2015 and the portion of the

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

award, if any, earned with respect to the final two performance periods will vest on January 1, 2016 and January 1, 2017, respectively; and (b) by non-executive management with respect to all three performance periods will vest 75% of the earned amount on the first business day of 2015, and the remaining 25% of the earned amount on the first business day of 2016. Compensation expense related to these awards is recognized over the requisite service period based on the Company’s estimate of the achievement of the performance target and vesting period. As of June 30, 2012, the Company estimates that it will issue 100% of the performance target awards for PVRSUs granted during 2012.

The fair value of a PVRSU is measured by reference to the closing market price of the Company’s common stock on the date of the grant. Compensation expense is recognized on a straight-line basis over the requisite service period based on the number of PVRSUs expected to vest.

The following table summarizes the Company’s non-vested PVRSU activity for the six months ended June 30, 2012:

 

     Shares     Weighted-
Average
Grant Date
Fair Value
     Aggregate
Intrinsic
Value

(in  millions)
 

Non-vested December 31, 2011

     834,375     $ 19.97     

Granted

     601,715       36.34     

Vested

     (582,281     15.58     

Forfeited

     (69,504     25.97     
  

 

 

      

Non-vested June 30, 2012

     784,305     $ 35.26      $ 26.2  
  

 

 

      

During the six months ended June 30, 2012, 582,281 PVRSUs vested with a total aggregate intrinsic value of $19.9 million. The Company repurchased 210,664 shares of common stock for an aggregate purchase price of $7.2 million pursuant to the participants’ rights under the Plans to elect to use common stock to satisfy their tax withholding obligations.

Restricted Stock Units

The following table summarizes the Company’s restricted stock units activity for the six months ended June 30, 2012:

 

     Shares     Weighted-
Average
Grant Date
Fair Value
     Aggregate
Intrinsic
Value

(in  millions)
 

Outstanding at December 31, 2011

     248,938     $ 24.44     

Granted

     706,268       35.98     

Vested

     (750     25.84     

Forfeited

     (9,890     37.05     
  

 

 

      

Outstanding at June 30, 2012

     944,566     $ 32.94      $ 31.5  
  

 

 

      

During the six months ended June 30, 2012, the Company granted 706,268 restricted stock units to certain employees with an aggregate fair value of $25.4 million. Restricted stock units granted to executive management will vest annually in five equal installments beginning on January 1, 2013. Restricted stock units granted to non-executive management will vest annually in four equal installments beginning on the first business day in 2013.

The restricted stock units previously issued to non-management directors of the Company’s Board of Directors will fully vest on the earlier of the first anniversary of the date of grant or the day preceding the date in the following calendar year on which the Company’s annual meeting of stockholders is held. Upon vesting of restricted stock units granted prior to 2011, each director’s restricted stock units will automatically be converted into deferred stock units, and will be delivered to the director in shares of the Company’s stock six months following the director’s termination of board service. Upon vesting of restricted stock units that were granted in 2011, each director’s restricted stock units will automatically be converted into deferred stock units and will be delivered to the director in shares of the Company’s stock six months following the director’s termination of board service unless a director elected near-term delivery, in which case the vested restricted stock units will be delivered on August 15, 2012.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Share Repurchase Program

On March 14, 2012, the Company announced the resumption of its three-year share repurchase program authorized by the Board of Directors in 2010, under which the Company may purchase up to $300 million in value of its Class A common shares. Share repurchases may be made through 10b5-1 plans, open market purchases, privately negotiated transactions or otherwise as market conditions warrant, at prices the Company deems appropriate, and subject to applicable legal requirements and other factors.

During the three and six months ended June 30, 2012, the Company repurchased 0.7 million shares and 1.4 million shares of its Class A common stock at an average price per share of $33.67 and $34.95, respectively, for a total purchase price of $25.0 million and $48.8 million, respectively. As of June 30, 2012, a total of 5.9 million shares at an average price of $27.72 per share had been repurchased under this program for an aggregate purchase price of $163.5 million. All repurchased shares are accounted for as treasury shares.

9. BASIC AND DILUTED NET INCOME PER COMMON SHARE

The following table provides a reconciliation of the numerators and denominators used in computing basic and diluted net income per common share (in thousands, except per share data):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011     2012      2011      2012  

Computation of basic net income per common share:

          

Income from continuing operations

   $ 33,616     $ 38,592      $ 67,081      $ 72,554  

(Loss) income from discontinued operations, net of tax

     (1,261     —           37,249        —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income

   $ 32,355     $ 38,592      $ 104,330      $ 72,554  
  

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average common shares and participating securities outstanding – basic

     73,807       66,917        73,872        67,060  
  

 

 

   

 

 

    

 

 

    

 

 

 

Basic net income per common share from:

          

Continuing operations

   $ 0.46     $ 0.58      $ 0.91      $ 1.08  

Discontinued operations

     (0.02     —           0.50        —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Basic net income per common share

   $ 0.44     $ 0.58      $ 1.41      $ 1.08  
  

 

 

   

 

 

    

 

 

    

 

 

 

Computation of diluted net income per common share:

          

Weighted average common shares and participating securities outstanding – basic

     73,807       66,917        73,872        67,060  

Effect of dilutive securities:

          

Stock-based awards

     1,208       970        1,257        1,072  
  

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding – diluted

     75,015       67,887        75,129        68,132  
  

 

 

   

 

 

    

 

 

    

 

 

 

Diluted net income per common share from:

          

Continuing operations

   $ 0.45     $ 0.57      $ 0.89      $ 1.06  

Discontinued operations

     (0.02     —           0.50        —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Diluted net income per common share

   $ 0.43     $ 0.57      $ 1.39      $ 1.06  
  

 

 

   

 

 

    

 

 

    

 

 

 

Diluted net income per common share reflects the potential dilution of common stock equivalents such as options and warrants, to the extent the impact is dilutive. The Company used income from continuing operations as the control number in determining whether potential common shares were dilutive or anti-dilutive. The same number of potential common shares used in computing the diluted per-share amount from continuing operations was also used in computing the diluted per-share amounts from discontinued operations even if those amounts were anti-dilutive.

 

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Stock-based awards to purchase an aggregate of 5,312,684 and 1,966,487 shares were excluded from the calculation of the denominator for diluted net income per common share for the three months ended June 30, 2011 and 2012, respectively, due to their anti-dilutive effects. Stock-based awards to purchase an aggregate of 4,766,669 and 1,617,941 shares were excluded from the calculation of the denominator for diluted net income per common share for the six months ended June 30, 2011 and 2012, respectively, due to their anti-dilutive effects.

10. COMPREHENSIVE INCOME

Comprehensive income is comprised of net earnings and other comprehensive income, which includes certain changes in equity that are excluded from income.

The following table summarizes the activity for each component of total comprehensive income during the six months ended June 30, 2012 (in thousands):

 

     December 31, 2011     (Loss) Gain     June 30, 2012  

Foreign currency translation adjustment

   $ (780   $ (16   $ (796

Unrealized gains on available-for-sale investments

     22       58       80  
  

 

 

   

 

 

   

 

 

 

Accumulated other comprehensive loss

   $ (758   $ 42     $ (716
  

 

 

   

 

 

   

 

 

 

11. RESTRUCTURING CHARGES

2011 Restructuring Plan

In the fourth quarter of 2011, the Company initiated a domestic work-force reduction impacting each of its operating segments and recorded severance and severance-related charges of $3.1 million. During the six months ended June 30, 2012, the Company incurred additional severance and severance-related charges of approximately $0.5 million. The Company expects to pay approximately $0.8 million in remaining severance and severance-related payments through the second quarter of 2013.

2010 Management Transition

In the fourth quarter of 2010, the Company initiated a work-force reduction impacting its Carrier Services and Enterprise Services operating segments and recorded severance and severance-related charges of $3.8 million. During the first quarter of 2011, the Company recorded additional severance and severance-related charges of $0.4 million in connection with this restructuring initiative. The Company does not anticipate it will incur additional expenses under this plan and expects to pay approximately $0.2 million in remaining severance and severance-related payments through the third quarter of 2012.

Converged Messaging Services, Discontinued Operations

Beginning in the fourth quarter of 2008, management committed to and implemented a restructuring plan for the Company’s Converged Messaging Services business, previously known as the Company’s Next Generation Messaging business, to more appropriately allocate resources to the Company’s key mobile instant messaging initiatives. The restructuring plan involved a reduction in headcount and closure of specific leased facilities in some of the Company’s international locations. In the third quarter of 2009 and the fourth quarter of 2010, the Company extended the restructuring plan to include further headcount reductions and closure of certain additional facilities. During 2011, the Company sold certain assets and liabilities of Neustar NGM Services, Inc. and its subsidiaries used in the Converged Messaging Services business, and completed the wind-down of the residual operations of its Converged Messaging Services business. Restructuring charges for all periods presented have been reclassified into “Income from discontinued operations, net of tax” in the Company’s consolidated statements of operations.

Total net restructuring charges recorded under this plan since the fourth quarter of 2008 include approximately $8.4 million of severance and severance-related costs and $1.8 million of lease and facility exit costs. Amounts related to lease terminations due to the closure of excess facilities will be paid over the remainder of the respective lease terms, the longest of which extends through 2013.

 

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Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Summary of Accrued Restructuring Plans

The additions and adjustments to the accrued restructuring liability related to the Company’s restructuring plans as described above for the six months ended June 30, 2012 are as follows (in thousands):

 

     December 31,
2011
     Additional
Costs
     Cash
Payments
    Other
Adjustments
    June 30,
2012
 

Converged Messaging Services:

            

Lease and facilities exit costs

   $ 609      $ —         $ (320   $ —        $ 289  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Converged Messaging Services

     609        —           (320     —          289  

2011 Management Transition:

            

Severance and related costs

     2,833        615        (2,608     (67     773  

2010 Management Transition:

            

Severance and related costs

     919        —           (670     (24     225  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total restructuring plans

   $ 4,361      $ 615      $ (3,598   $ (91   $ 1,287  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

12. OTHER (EXPENSE) INCOME

Other (expense) income consists of the following (in thousands):

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2011     2012      2011      2012  

Interest and other expense:

          

Interest expense

   $ 72     $ 8,254      $ 281      $ 16,867  

Loss (gain) on asset disposals

     (48     85        64        (45

Foreign currency transaction losses (gains)

     102       65        128        (225
  

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 126     $ 8,404      $ 473      $ 16,597  
  

 

 

   

 

 

    

 

 

    

 

 

 

Interest and other income:

          

Interest income

   $ 257     $ 110      $ 460      $ 339  

Available-for sale realized gains

     673       —           673        —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 930     $ 110      $ 1,133      $ 339  
  

 

 

   

 

 

    

 

 

    

 

 

 

13. INCOME TAXES

The Company’s effective tax rate from continuing operations decreased to 37.7 % for the six months ended June 30, 2012 from 40.2% for six months ended June 30, 2011 primarily due to the utilization of foreign tax credits against federal income taxes.

On February 7, 2011, the Company sold certain business assets and liabilities of Neustar NGM Services, Inc. (NGM Services) and its subsidiaries, a portion of the Converged Messaging Services business. The Company intends to treat the common stock of NGM Services as worthless for U.S. income tax purposes in its 2011 U.S. federal and state income tax returns. As a result, the Company recorded an income tax benefit of $42.7 million for the three months ended March 31, 2011 within discontinued operations, which primarily represents the book and tax basis differences associated with its investment in NGM Services.

As of December 31, 2011 and June 30, 2012, the Company had unrecognized tax benefits of $1.6 million and $1.7 million, respectively, of which $1.6 million and $1.7 million, respectively, would affect the Company’s effective tax rate if recognized.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. During the three months ended June 30, 2011 and 2012, the Company recognized potential interest and penalties of $9,000 and $39,000, respectively, and $48,000, and $90,000 for the six months ended June 30, 2011 and 2012, respectively, including interest related to uncertain tax positions of companies acquired. As of December 31, 2011 and June 30, 2012, the Company had established reserves of approximately $153,000 and $243,000, respectively, for accrued potential interest and penalties related to uncertain tax positions. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.

 

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Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

The Company files income tax returns in the United States Federal jurisdiction and in many state and foreign jurisdictions. The tax years 2007 through 2011 remain open to examination by the major taxing jurisdictions to which the Company is subject. The Internal Revenue Service (IRS) has initiated an examination of the Company’s 2009 federal income tax return. While the ultimate outcome of the audit is uncertain, management does not currently believe that the outcome will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

The Company anticipates that total unrecognized tax benefits will decrease by approximately $565,000 over the next 12 months due to the expiration of certain statutes of limitations and settlement of tax audits.

14. SEGMENT INFORMATION

The Company has three operating segments, reflective of the manner in which the chief operating decision maker (CODM) allocates resources and assesses performance: Carrier Services, Enterprise Services, and Information Services. On November 8, 2011, the Company completed its acquisition of TARGUSinfo and introduced its new Information Services operating segment. The Company’s operating segments are the same as its reportable segments.

The Company’s Carrier Services operating segment provides services that ensure the seamless connection of its carrier customers’ numerous networks, while also enhancing the capabilities and performance of its customers’ infrastructure. The Company enables its carrier customers to use, exchange and share critical resources, such as telephone numbers, to facilitate order management and work flow processing among carriers, and allows operators to manage and optimize the addressing and routing of IP communications.

The Company’s Enterprise Services operating segment provides services to its enterprise customers to meet their respective directory-related needs, as well as IIS. The Company is the authoritative provider of essential registry services and manages directories of similar resources, or addresses, that its customers use for reliable, fair and secure access and connectivity. The Company provides a suite of DNS services to its enterprise customers built on a global directory platform. The Company manages a collection of directories that maintain addresses in order to direct, prioritize and manage Internet traffic, and to find and resolve Internet queries and top-level domains. The Company’s services monitor and load-test websites to help identify issues and optimize performance. In addition, the Company provides fixed IP geolocation services that help enterprises identify the location of their consumers used in a variety of purposes, including fraud prevention and marketing. Additionally, the Company provides directory services for the 5- and 6-digit number strings used for all U.S. Common Short Codes, which is part of the short messaging service relied upon by the U.S. wireless industry. In addition, the Company operates the digital content authentication directory, which supports the UltraVioletTM digital content locker by which consumers can gain access to their entertainment content.

The Company’s Information Services operating segment provides a broad portfolio of real-time information and analytics services that enable clients to identify, verify and score their customers and prospective customers, or prospects, to deliver customized responses to a large number of consumer-initiated queries. As an example, the Company provides marketers with the ability to tailor offers made to consumers over the telephone or on the Internet in real time. The Company is one of the largest non-carrier providers of Caller ID services, and provides a comprehensive market analytics platform that enables clients to segment and score customers and prospects for real-time interactive marketing initiatives. The Company’s online audience solution enables online advertisers to display relevant advertisements to specific audiences, increasing the effectiveness of online advertising and delivering a more useful online experience for consumers using a database and targeting system that protect a consumer’s privacy.

The Company reports segment information based on the “management” approach which relies on the internal performance measures used by the CODM to assess the performance of each operating segment in a given period. In connection with that assessment, the CODM reviews revenues and segment contribution, which excludes certain unallocated costs within the following expense classifications: cost of revenue, sales and marketing, research and development and general and administrative. Depreciation and amortization and restructuring charges are also excluded from segment contribution.

 

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Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

Information for the three and six months ended June 30, 2011 and 2012 regarding the Company’s reportable segments from continuing operations was as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011     2012      2011      2012  

Revenue:

          

Carrier Services

   $ 110,834     $ 126,347      $ 220,449      $ 250,720  

Enterprise Services

     36,849       42,089        73,329        81,574  

Information Services

     —          38,026        —           73,750  
  

 

 

   

 

 

    

 

 

    

 

 

 

Total revenue

   $ 147,683     $ 206,462      $ 293,778      $ 406,044  
  

 

 

   

 

 

    

 

 

    

 

 

 

Segment contribution:

          

Carrier Services

   $ 97,570     $ 110,438      $ 194,149      $ 218,884  

Enterprise Services

     15,418       18,866        31,069        35,597  

Information Services

     —          16,991        —           35,005  
  

 

 

   

 

 

    

 

 

    

 

 

 

Total segment contribution

     112,988       146,295        225,218        289,486  

Indirect operating expenses:

          

Cost of revenue (excluding depreciation and amortization shown separately below)

     19,742       24,741        39,369        49,010  

Sales and marketing

     4,617       6,635        8,442        12,365  

Research and development

     2,912       4,431        6,510        9,291  

General and administrative

     21,108       19,413        40,395        40,131  

Depreciation and amortization

     9,386       22,713        18,532        45,419  

Restructuring (recoveries) charges

     (12     2        420        524  
  

 

 

   

 

 

    

 

 

    

 

 

 

Income from operations

   $ 55,235     $ 68,360      $ 111,550      $ 132,746  
  

 

 

   

 

 

    

 

 

    

 

 

 

Assets are not tracked by segment and the CODM does not evaluate segment performance based on asset utilization.

Enterprise-Wide Disclosures

Geographic area revenues and service offering revenues from external customers for the three and six months ended June 30, 2011 and 2012, and geographic area long-lived assets as of December 31, 2011 and June 30, 2012 are as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2012      2011      2012  

Revenues by geographical areas:

           

North America

   $ 137,996      $ 194,247      $ 275,089      $ 383,595  

Europe and Middle East

     6,316        7,940        11,881        14,233  

Other regions

     3,371        4,275        6,808        8,216  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 147,683      $ 206,462      $ 293,778      $ 406,044  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2012

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2012      2011      2012  

Revenues by service offerings:

           

Carrier Services:

           

Numbering Services

   $ 98,813      $ 110,896      $ 198,239      $ 221,385  

Order Management Services

     8,481        10,541        15,625        21,451  

IP Services

     3,540        4,910        6,585        7,884  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Carrier Services

     110,834        126,347        220,449        250,720  

Enterprise Services:

           

Internet Infrastructure Services

     20,117        22,455        40,521        44,178  

Registry Services

     16,732        19,634        32,808        37,396  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Enterprise Services

     36,849        42,089        73,329        81,574  

Information Services:

           

Identification Services

     —           22,957        —           45,676  

Verification & Analytics Services

     —           9,821        —           18,057  

Local Search & Licensed Data Services

     —           5,248        —           10,017  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Information Services

     —           38,026        —           73,750  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 147,683      $ 206,462      $ 293,778      $ 406,044  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2011
     June 30,
2012
 

Long-lived assets, net

     

North America

   $ 438,799      $ 422,231   

Central America

     45        27   

Europe and Middle East

     25        17   

Other regions

     1        1   
  

 

 

    

 

 

 

Total long-lived assets, net

   $ 438,870      $ 422,276   
  

 

 

    

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements, including, without limitation, statements concerning the conditions in our industry, our operations and economic performance, and our business and growth strategy. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Many of these risks are beyond our ability to control or predict. These forward-looking statements are based on estimates and assumptions by our management that we believe to be reasonable but are inherently uncertain and subject to a number of risks and uncertainties. These risks and uncertainties include, without limitation, those described in this report, in Part II, “Item 1A. Risk Factors” and in subsequent filings with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as required by law.

Overview

During the second quarter we continued to experience increased demand for our services. Total revenue for the quarter increased 40% as compared to the second quarter of 2011. Of this growth, our newly formed Information Services segment contributed 26%, while Carrier Services contributed 10% and Enterprise Services contributed 4%.

Carrier Services revenue grew 14% as compared to the second quarter of 2011, driven by a 12% increase in the fixed fee established under our contracts to provide NPAC services. During the quarter, we also saw increased demand for our Enterprise Services, resulting in a 14% year-over-year growth. In particular, revenue from Registry Services grew 17% compared to the second quarter of 2011 due to continued growth in the number of domain names and common short codes under management and an increase in revenue from media services. Additionally, Internet Infrastructure Services, or IIS, revenue grew 12% year-over-year due to increased demand for our protect service offerings.

Further, we continued our capital allocation strategy of returning cash to shareholders through a share repurchase program. During the second quarter of 2012, we repurchased approximately 742,000 shares of our common stock at an average price of $33.67 per share for a total of $25.0 million. As of June 30, 2012, the remaining authorized amount under our share repurchase program is approximately $136.3 million.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based on our unaudited consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. The preparation of these financial statements in accordance with U.S. GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expense during a fiscal period. The Securities and Exchange Commission, or SEC, considers an accounting policy to be critical if it is important to a company’s financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures in this report.

Although we believe that our judgments and estimates are appropriate and reasonable, actual results may differ from those estimates. In addition, while we have used our best estimates based on the facts and circumstances available to us at the time, we reasonably could have used different estimates in the current period. Changes in the accounting estimates we use are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations could be materially affected. See the information in our filings with the SEC from time to time, including Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, for certain matters that may bear on our results of operations.

The following discussion of selected critical accounting policies supplements the information relating to our critical accounting policies described in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

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Table of Contents

Stock-Based Compensation

We recognize stock-based compensation expense in accordance with the Compensation – Stock Compensation Topic of the FASB ASC which requires the measurement and recognition of compensation expense for stock-based awards granted to employees based on estimated fair values on the date of grant.

See Note 8 to our Unaudited Consolidated Financial Statements in Item 1 of Part I of this report for information regarding our assumptions related to stock-based compensation and the amount of stock-based compensation expense we incurred for the periods covered in this report.

We estimate the fair value of our restricted stock unit awards based on the fair value of our common stock on the date of grant. Our outstanding restricted stock unit awards are subject to service-based vesting conditions and performance-based vesting conditions. We recognize the estimated fair value of service-based awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period on a straight-line basis. Awards with performance-based vesting conditions require the achievement of specific financial targets at the end of the specified performance period and the employee’s continued employment over the vesting period. We recognize the estimated fair value of performance-based awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period, which considers each performance period or tranche separately, based upon our determination of whether it is probable that the performance targets will be achieved. At each reporting period, we reassess the probability of achieving the performance targets within the related performance period. Determining whether the performance targets will be achieved involves judgment, and the estimate of stock-based compensation expense may be revised periodically based on changes in the probability of achieving the performance targets. If any performance goals are not met, no compensation cost is ultimately recognized against that goal, and to the extent previously recognized, compensation cost is reversed. As of June 30, 2012, we estimated that the level of achievement of the performance targets for performance vested restricted stock units granted during 2012 was 100%.

 

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Consolidated Results of Operations

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2012

The following table presents an overview of our results of operations for the three months ended June 30, 2011 and 2012:

 

     Three Months Ended June 30,  
     2011     2012     2011 vs. 2012  
     $     $     $ Change     % Change  
     (unaudited)  
     (dollars in thousands, except per share data)  

Revenue:

        

Carrier Services

   $ 110,834     $ 126,347     $ 15,513       14.0

Enterprise Services

     36,849       42,089       5,240       14.2

Information Services

     —          38,026       38,026       100.0
  

 

 

   

 

 

   

 

 

   

Total revenue

     147,683       206,462       58,779       39.8

Operating expense:

        

Cost of revenue (excludes depreciation and amortization shown separately below)

     31,417       46,127       14,710       46.8

Sales and marketing

     26,267       41,073       14,806       56.4

Research and development

     3,441       8,096       4,655       135.3

General and administrative

     21,949       20,091       (1,858     (8.5 )% 

Depreciation and amortization

     9,386       22,713       13,327       142.0

Restructuring (recoveries) charges

     (12     2       14       (116.7 )% 
  

 

 

   

 

 

   

 

 

   
     92,448       138,102       45,654       49.4
  

 

 

   

 

 

   

 

 

   

Income from operations

     55,235       68,360       13,125       23.8

Other (expense) income:

        

Interest and other expense

     (126     (8,404     (8,278     6,569.8

Interest and other income

     930       110       (820     (88.2 )% 
  

 

 

   

 

 

   

 

 

   

Income from continuing operations before income taxes

     56,039       60,066       4,027       7.2

Provision for income taxes, continuing operations

     22,423       21,474       (949     (4.2 )% 
  

 

 

   

 

 

   

 

 

   

Income from continuing operations

     33,616       38,592       4,976       14.8

(Loss) income from discontinued operations, net of tax

     (1,261     —          1,261       (100.0 )% 
  

 

 

   

 

 

   

 

 

   

Net income

   $ 32,355     $ 38,592     $ 6,237       19.3
  

 

 

   

 

 

   

 

 

   

Basic net income per common share:

        

Continuing operations

   $ 0.46     $ 0.58      

Discontinued operations

     (0.02     —         
  

 

 

   

 

 

     

Basic net income per common share

   $ 0.44     $ 0.58      
  

 

 

   

 

 

     

Diluted net income per common share:

        

Continuing operations

   $ 0.45     $ 0.57      

Discontinued operations

     (0.02     —         
  

 

 

   

 

 

     

Diluted net income per common share

   $ 0.43     $ 0.57      
  

 

 

   

 

 

     

Weighted average common shares outstanding:

        

Basic

     73,807       66,917      
  

 

 

   

 

 

     

Diluted

     75,015       67,887      
  

 

 

   

 

 

     

 

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Revenue

Carrier Services. Revenue from our Carrier Services operating segment increased $15.5 million due to an increase of $12.1 million in revenue from Numbering Services and an increase of $2.1 million in revenue from Order Management Services, or OMS. The $12.1 million increase in revenue from Numbering Services was primarily the result of an $11.3 million increase in the fixed fee established under our contracts to provide NPAC Services. The OMS revenue increase was primarily due to our acquisition of numbering assets completed in the third quarter of 2011.

Enterprise Services. Revenue from our Enterprise Services operating segment increased $5.2 million due to an increase of $2.9 million in revenue from Registry Services. This increase was due to growth in the number of domain names and common short codes under management and revenue from system enhancements in media services. In addition, revenue from Internet Infrastructure Services, or IIS, increased $2.3 million primarily due to increased demand for our managed domain name systems, or DNS, solutions to direct and manage Internet traffic.

Information Services. In the fourth quarter of 2011, we completed the acquisition of TARGUSinfo and established Information Services as a new operating segment. Revenue from our Information Services operating segment was $38.0 million, comprised of $23.0 million in Identification Services, $9.8 million in Verification & Analytics Services, and $5.2 million in Local Search and Licensed Data Services.

Expense

Cost of revenue. Cost of revenue increased $14.7 million, including $8.7 million of operating costs related to acquisitions completed subsequent to June 30, 2011. The overall increase of $14.7 million in cost of revenue was due to a $5.0 million increase in personnel and personnel-related expense. This increase in personnel and personnel-related expense was due to increased headcount in our technology teams to support system enhancements for new and existing service offerings. In addition, costs relating to our information technology and systems, including data processing costs and general facilities costs, increased $6.4 million due to growth in our business. Furthermore, royalty expense increased $2.3 million due to revenue growth and contractor costs increased $1.0 million as a result of increased costs incurred for customer deployment.

Sales and marketing. Sales and marketing expense increased $14.8 million, including $11.5 million of operating costs related to acquisitions subsequent to June 30, 2011. The overall increase of $14.8 million in sales and marketing expense was due to an $11.8 million increase in personnel and personnel-related expense related to our expanded sales and marketing teams to support our new and diversified service offerings. In addition, advertising and external marketing costs increased $1.8 million to increase brand awareness and general facilities costs increased $1.2 million.

Research and development. Research and development expense increased $4.7 million, including $3.1 million of operating costs related to acquisitions subsequent to June 30, 2011. The overall increase of $4.7 million in research and development expense was due to an increase of $3.5 million in personnel and personnel-related expense due to new development initiatives. In addition, contractor costs increased $0.6 million to augment internal development resources and general facilities costs increased $0.6 million.

General and administrative. General and administrative expense decreased $1.9 million, including a $1.6 million increase in operating costs related to acquisitions subsequent to June 30, 2011. The overall decrease of $1.9 million was due to a decrease $1.2 million in consulting costs primarily due to costs incurred in the second quarter of 2011 to pursue new business opportunities for which there was no corresponding expense in the second quarter of 2012. In addition, general and administrative facilities costs decreased $0.8 million.

Depreciation and amortization. Depreciation and amortization expense increased $13.3 million, including $12.2 million in expense related to acquisitions subsequent to June 30, 2011. The overall increase of $13.3 million in expense was due to an increase in amortization expense of $11.5 million as a result of the amortization of intangible assets acquired in connection with our acquisitions. In addition, depreciation expense increased $1.8 million due to acquisitions of new property and equipment, including furniture and fixtures and leasehold improvements.

Restructuring (recoveries) charges. Restructuring charges for the three months ended June 30, 2012 was comparable to the restructuring (recoveries) for the three months ended June 30, 2011 and include adjustments to restructuring plans initiated prior to 2012. Restructuring charges recorded in the second quarter of 2012 were attributable to our 2011 domestic work-force reduction initiated in the fourth quarter of 2011. Restructuring recoveries recorded in the second quarter of 2011 were attributable to our 2010 management transition plan.

Interest and other expense. Interest and other expense increased $8.3 million due to an $8.2 million increase in interest expense attributable to our 2011 credit facility, including amortization of related deferred financing costs.

 

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Interest and other income. Interest and other income decreased $0.8 million due to a decrease of $0.7 million in realized gains for our available-for-sale securities sold during the three months June 30, 2011.

Provision for income taxes, continuing operations. Our estimated annual effective tax rate decreased to 35.8% for the three months ended June 30, 2012 from 40.0% for the three months ended June 30, 2011 primarily due to the utilization of foreign tax credits against federal income taxes.

Loss from discontinued operations, net of tax. During the second quarter of 2011, we completed our plan to wind down and cease operations of our Converged Messaging Services business, following the sale in February 2011 of certain assets and liabilities of Neustar NGM Services, Inc., or NGM Services, and its subsidiaries. The financial results for the three months ended June 30, 2011 and 2012 reflect the results of operations, net of tax, of the Converged Messaging Services business as discontinued operations.

Summary of Operating Segments

The following table presents a summary of our operating segments’ revenue, contribution and the reconciliation to income from operations for the three months ended June 30, 2011 and 2012 (in thousands):

 

     Three Months Ended June 30,  
     2011     2012      2011 vs. 2012  
     $     $      $ Change     % Change  

Revenue:

         

Carrier Services

   $ 110,834     $ 126,347      $ 15,513       14.0

Enterprise Services

     36,849       42,089        5,240       14.2

Information Services

     —          38,026        38,026       100.0
  

 

 

   

 

 

    

 

 

   

Total revenue

   $ 147,683     $ 206,462      $ 58,779       39.8
  

 

 

   

 

 

    

 

 

   

Segment contribution:

         

Carrier Services

   $ 97,570     $ 110,438      $ 12,868       13.2

Enterprise Services

     15,418       18,866        3,448       22.4

Information Services

     —          16,991        16,991       100.0
  

 

 

   

 

 

    

 

 

   

Total segment contribution

     112,988       146,295        33,307       29.5

Indirect operating expenses:

         

Cost of revenue (excluding depreciation and amortization shown separately below)

     19,742       24,741        4,999       25.3

Sales and marketing

     4,617       6,635        2,018       43.7

Research and development

     2,912       4,431        1,519       52.2

General and administrative

     21,108       19,413        (1,695     (8.0 )% 

Depreciation and amortization

     9,386       22,713        13,327       142.0

Restructuring (recoveries) charges

     (12     2        14       (116.7 )% 
  

 

 

   

 

 

    

 

 

   

Income from operations

   $ 55,235     $ 68,360      $ 13,125       23.8
  

 

 

   

 

 

    

 

 

   

Segment contribution is determined based on internal performance measures used by the chief operating decision maker, or CODM, to assess the performance of each operating segment in a given period. In connection with this assessment, the CODM reviews revenue and segment contribution, which excludes certain unallocated costs within the following expense classifications: cost of revenue, sales and marketing, research and development and general and administrative. Depreciation and amortization and restructuring (recoveries) charges are also excluded from the segment contribution.

The following is a discussion of our operating segment results for the three months ended June 30, 2011 and 2012:

Carrier Services. Revenue from our Carrier Services operating segment increased $15.5 million due to an increase of $12.1 million in revenue from Numbering Services and an increase of $2.1 million in revenue from OMS. The $12.1 million increase in revenue from Numbering Services was primarily the result of an $11.3 million increase in the fixed fee established under our contracts to provide NPAC Services. The OMS revenue increase was primarily due to our acquisition of numbering assets completed in the third quarter of 2011. Segment operating costs for Carrier Services totaled $15.9 million, an increase of $2.6 million. This increase in segment operating costs was to support the increased OMS revenue. In particular, personnel and personnel-related expense increased $2.3 million due to increased headcount attributable to the acquisition and to support revenue growth. Carrier Services segment revenue less its segment operating costs resulted in a segment contribution of $110.4 million, an increase of $12.9 million.

 

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Enterprise Services. Revenue from our Enterprise Services operating segment increased $5.2 million due to an increase of $2.9 million in revenue from Registry Services. This increase was due to growth in the number of domain names and common short codes under management and revenue from system enhancements in media services. In addition, revenue from IIS increased $2.3 million primarily due to increased demand for our managed DNS solutions to direct and manage Internet traffic. Segment operating costs for Enterprise Services totaled $23.2 million, an increase of $1.8 million. This increase in segment operating costs was due to an increase of $0.9 million in Registry Services royalty expense driven by increased revenue from managing a larger number of common short codes and domain names and an increase of $0.6 million in marketing expense to support brand awareness. Enterprise Services segment revenue less its segment operating costs resulted in a segment contribution of $18.9 million, an increase of $3.4 million.

Information Services. In the fourth quarter of 2011, we completed the acquisition of TARGUSinfo and established Information Services as a new operating segment. Revenue from our Information Services operating segment was $38.0 million, comprised of $23.0 million in Identification Services, $9.8 million in Verification & Analytics Services, and $5.2 million in Local Search and Licensed Data Services. Segment operating costs for Information Services totaled $21.0 million and included $14.8 million in personnel and personnel-related expense, $4.1 million in costs related to our information technology and systems and $1.8 million in general facilities costs. Information Services segment revenue less its segment operating costs resulted in a segment contribution of $17.0 million.

 

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Consolidated Results of Operations

Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2012

The following table presents an overview of our results of operations for the six months ended June 30, 2011 and 2012:

 

     Six Months Ended June 30,  
     2011     2012     2011 vs. 2012  
     $     $     $ Change     % Change  
     (unaudited)  
     (dollars in thousands, except per share data)  

Revenue:

        

Carrier Services

   $ 220,449     $ 250,720     $ 30,271       13.7

Enterprise Services

     73,329       81,574       8,245       11.2

Information Services

     —          73,750       73,750       100.0
  

 

 

   

 

 

   

 

 

   

Total revenue

     293,778       406,044       112,266       38.2

Operating expense:

        

Cost of revenue (excludes depreciation and amortization shown separately below)

     62,469       91,025       28,556       45.7

Sales and marketing

     51,206       79,426       28,220       55.1

Research and development

     7,437       15,820       8,383       112.7

General and administrative

     42,164       41,084       (1,080     (2.6 )% 

Depreciation and amortization

     18,532       45,419       26,887       145.1

Restructuring charges

     420       524       104       24.8
  

 

 

   

 

 

   

 

 

   
     182,228       273,298       91,070       50.0
  

 

 

   

 

 

   

 

 

   

Income from operations

     111,550       132,746       21,196       19.0

Other (expense) income:

        

Interest and other expense

     (473     (16,597     (16,124     3,408.9

Interest and other income

     1,133       339       (794     (70.1 )% 
  

 

 

   

 

 

   

 

 

   

Income from continuing operations before income taxes

     112,210       116,488       4,278       3.8

Provision for income taxes, continuing operations

     45,129       43,934       (1,195     (2.6 )% 
  

 

 

   

 

 

   

 

 

   

Income from continuing operations

     67,081       72,554       5,473       8.2

Income from discontinued operations, net of tax

     37,249       —          (37,249     (100.0 )% 
  

 

 

   

 

 

   

 

 

   

Net income

   $ 104,330     $ 72,554     $ (31,776     (30.5 )% 
  

 

 

   

 

 

   

 

 

   

Basic net income per common share:

        

Continuing operations

   $ 0.91     $ 1.08      

Discontinued operations

     0.50       —         
  

 

 

   

 

 

     

Basic net income per common share

   $ 1.41     $ 1.08      
  

 

 

   

 

 

     

Diluted net income per common share:

        

Continuing operations

   $ 0.89     $ 1.06      

Discontinued operations

     0.50       —         
  

 

 

   

 

 

     

Diluted net income per common share

   $ 1.39     $ 1.06      
  

 

 

   

 

 

     

Weighted average common shares outstanding:

        

Basic

     73,872       67,060      
  

 

 

   

 

 

     

Diluted

     75,129       68,132      
  

 

 

   

 

 

     

 

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Revenue

Carrier Services. Revenue from our Carrier Services operating segment increased $30.3 million due to an increase of $23.1 million in revenue from Numbering Services and an increase of $5.8 million in revenue from OMS. The $23.1 million increase in revenue from Numbering Services was primarily the result of a $22.5 million increase in the fixed fee established under our contracts to provide NPAC Services. The OMS revenue increase was primarily due to our acquisition of numbering assets completed in the third quarter of 2011.

Enterprise Services. Revenue from our Enterprise Services operating segment increased $8.2 million due to an increase of $4.6 million in revenue from Registry Services. This increase was due to growth in the number of domain names and common short codes under management and revenue from system enhancements in media services. In addition, revenue from IIS increased $3.6 million primarily due to increased demand for our DNS solutions to direct and manage Internet traffic.

Information Services. In the fourth quarter of 2011, we completed the acquisition of TARGUSinfo and established Information Services as a new operating segment. Revenue from our Information Services operating segment was $73.8 million, comprised of $45.7 million in Identification Services, $18.1 million in Verification & Analytics Services, and $10.0 million in Local Search and Licensed Data Services.

Expense

Cost of revenue. Cost of revenue increased $28.6 million, including $17.7 million of operating costs related to acquisitions completed subsequent to June 30, 2011. The overall increase of $28.6 million in cost of revenue was due to a $10.8 million increase in personnel and personnel-related expense. This increase in personnel and personnel-related expense was due to increased headcount in our technology teams to support system enhancements for new and existing service offerings. In addition, costs relating to our information technology and systems, including data processing costs and general facilities costs, increased $11.1 million due to growth in our business. Furthermore, royalty expense increased $4.0 million due to revenue growth and contractor costs increased $2.6 million as a result of increased costs incurred for customer deployment.

Sales and marketing. Sales and marketing expense increased $28.2 million, including $20.6 million of operating costs related to acquisitions subsequent to June 30, 2011. The overall increase of $28.2 million in sales and marketing expense was due to a $22.7 million increase in personnel and personnel-related expense related to our expanded sales and marketing teams to support our new and diversified service offerings. In addition, advertising and external marketing costs increased $4.0 million to increase brand awareness and general facilities costs increased $1.5 million.

Research and development. Research and development expense increased $8.4 million, including $5.4 million of operating costs related to acquisitions subsequent to June 30, 2011. The overall increase of $8.4 million in research and development expense was due to an increase of $6.1 million in personnel and personnel-related expense due to new development initiatives. In addition, contractor costs increased $1.5 million to augment internal development resources and general facilities costs increased $0.8 million.

General and administrative. General and administrative expense decreased $1.1 million, including a $4.7 million increase in operating costs related to acquisitions subsequent to June 30, 2011. The overall decrease of $1.1 million was due to a decrease of $1.8 million in consulting costs attributable to costs incurred during 2011 to pursue new business opportunities for which there was no corresponding expense during 2012. This decrease was partially offset by an increase of $1.2 million in personnel and personnel-related costs.

Depreciation and amortization. Depreciation and amortization expense increased $26.9 million, including $24.5 million in expense related to acquisitions subsequent to June 30, 2011. The overall increase of $26.9 million in expense was due to an increase in amortization expense of $22.9 million as a result of the amortization of intangible assets acquired in connection with acquisitions. In addition, depreciation expense increased $4.0 million due to acquisitions of new property and equipment, including furniture and fixtures and leasehold improvements.

Restructuring charges. Restructuring charges increased $0.1 million due to severance and severance-related expense of $0.5 million attributable to our 2011 domestic work-force reduction initiated in the fourth quarter of 2011, partially offset by a decrease in severance and severance-related expense of $0.4 million attributable to our 2010 management transition plan.

Interest and other expense. Interest and other expense increased $16.1 million due to a $16.6 million increase in interest expense attributable to our 2011 credit facility, including amortization of related deferred financing costs. This increase was partially offset by a decrease of $0.4 million in foreign currency losses.

 

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Interest and other income. Interest and other income decreased $0.8 million due to a decrease of $0.7 million in realized gains for our available-for-sale securities sold during the three months June 30, 2011

Provision for income taxes, continuing operations. Our estimated annual effective tax rate decreased to 37.7% for the six months ended June 30, 2012 from 40.2% for the six months ended June 30, 2011 primarily due to the utilization of foreign tax credits against federal income taxes.

Income from discontinued operations, net of tax. During the second quarter of 2011, we completed our plan to wind down and cease operations of our Converged Messaging Services business, following the sale in February 2011 of certain assets and liabilities of NGM Services and its subsidiaries. The financial results for the six months ended June 30, 2011 and 2012 reflect the results of operations, net of tax, of the Converged Messaging Services business as discontinued operations. We intend to treat the common stock of NGM Services as worthless for U.S. income tax purposes in our 2011 U.S. federal and state income tax returns. As a result, we recorded a discrete income tax benefit of $42.7 million in the six months ended June 30, 2011.

Summary of Operating Segments

The following table presents a summary of our operating segments’ revenue, contribution and the reconciliation to income from operations for the six months ended June 30, 2011 and 2012 (in thousands):

 

     Six Months Ended June 30,  
     2011      2012      2011 vs. 2012  
     $      $      $ Change     % Change  

Revenue:

          

Carrier Services

   $ 220,449      $ 250,720      $ 30,271       13.7

Enterprise Services

     73,329        81,574        8,245       11.2

Information Services

     —           73,750        73,750       100.0
  

 

 

    

 

 

    

 

 

   

Total revenue

   $ 293,778      $ 406,044      $ 112,266       38.2
  

 

 

    

 

 

    

 

 

   

Segment contribution:

          

Carrier Services

   $ 194,149      $ 218,884      $ 24,735       12.7

Enterprise Services

     31,069        35,597        4,528       14.6

Information Services

     —           35,005        35,005       100.0
  

 

 

    

 

 

    

 

 

   

Total segment contribution

     225,218        289,486        64,268       28.5

Indirect operating expenses:

          

Cost of revenue (excluding depreciation and amortization shown separately below)

     39,369        49,010        9,641       24.5

Sales and marketing

     8,442        12,365        3,923       46.5

Research and development

     6,510        9,291        2,781       42.7

General and administrative

     40,395        40,131        (264     (0.7 )% 

Depreciation and amortization

     18,532        45,419        26,887       145.1

Restructuring charges

     420        524        104       24.8
  

 

 

    

 

 

    

 

 

   

Income from operations

   $ 111,550      $ 132,746      $ 21,196       19.0
  

 

 

    

 

 

    

 

 

   

Segment contribution is determined based on internal performance measures used by the CODM to assess the performance of each operating segment in a given period. In connection with this assessment, the CODM reviews revenue and segment contribution, which excludes certain unallocated costs within the following expense classifications: cost of revenue, sales and marketing, research and development and general and administrative. Depreciation and amortization and restructuring charges are also excluded from the segment contribution.

The following is a discussion of our operating segment results for the six months ended June 30, 2011 and 2012:

Carrier Services. Revenue from our Carrier Services operating segment increased $30.3 million due to an increase of $23.1 million in revenue from Numbering Services and an increase of $5.8 million in revenue from OMS. The $23.1 million increase in revenue from Numbering Services was primarily the result of a $22.5 million increase in the fixed fee established under our contracts to provide NPAC Services. The OMS revenue increase was primarily due to our acquisition of numbering assets completed in the third quarter of 2011. Segment operating costs for Carrier Services totaled $31.8 million, an increase of $5.5 million. This increase in segment operating costs was to support the increased OMS revenue. In particular, personnel and personnel-related expense increased $5.0 million due to increased headcount attributable to the acquisition and to support revenue growth. Carrier Services segment revenue less its segment operating costs resulted in a segment contribution of $218.9 million, an increase of $24.7 million.

 

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Enterprise Services. Revenue from our Enterprise Services operating segment increased $8.2 million due to an increase of $4.6 million in revenue from Registry Services. This increase was due to growth in the number of domain names and common short codes under management and revenue from system enhancements in media services. In addition, revenue from IIS increased $3.6 million primarily due to increased demand for our DNS solutions to direct and manage Internet traffic. Segment operating costs for Enterprise Services totaled $46.0 million, an increase of $3.7 million. This increase in segment operating costs was due to an increase of $1.9 million in Registry Services royalty expense driven by increased revenue from managing a larger number of common short codes and domain names, an increase of $1.4 million in personnel and personnel-related expense, and an increase of $0.8 million in marketing expense to support brand awareness. These increases were partially offset by a decrease of $0.4 million in general facilities costs and network costs. Enterprise Services segment revenue less its segment operating costs resulted in a segment contribution of $35.6 million, an increase of $4.5 million.

Information Services. In the fourth quarter of 2011, we completed the acquisition of TARGUSinfo and established Information Services as a new operating segment. Revenue from our Information Services operating segment was $73.8 million, comprised of $45.7 million in Identification Services, $18.1 million in Verification & Analytics Services, and $10.0 million in Local Search and Licensed Data Services. Segment operating costs for Information Services totaled $38.7 million and included $27.2 million in personnel and personnel-related expense, $8.4 million in costs related to our information technology and systems and $2.5 million in general facilities costs. Information Services segment revenue less its segment operating costs resulted in a segment contribution of $35.0 million.

Liquidity and Capital Resources

Our principal source of liquidity is cash provided by operating activities. Our principal uses of cash have been to fund share repurchases, capital expenditures and debt service requirements. We anticipate that our principal uses of cash in the future will be for share repurchases, capital expenditures, debt service requirements and acquisitions.

Total cash, cash equivalents and investments were $235.0 million at June 30, 2012, an increase of $99.7 million from $135.3 million at December 31, 2011. This increase in cash, cash equivalents and investments was primarily due to cash provided by operations.

We believe that our existing cash and cash equivalents, short-term investments, and cash from operations will be sufficient to fund our operations for the next twelve months.

Credit Facilities

On November 8, 2011, we entered into a credit agreement that includes: (1) a $600 million senior secured term loan facility, or Term Facility; and (2) a $100 million senior secured revolving credit facility, or Revolving Facility, and together with the Term Facility, the 2011 Facilities. The Revolving Facility matures on November 8, 2016, and the Term Facility matures on November 8, 2018. The entire $600 million Term Facility was borrowed on November 8, 2011, and used to fund a portion of the acquisition of TARGUSinfo and to pay costs, fees and expenses incurred in connection with the acquisition. We did not borrow any amounts under the Revolving Facility in 2011 or through the six months ended June 30, 2012.

Principal payments under the Term Facility of $1.5 million are due on the last day of the quarter starting on December 31, 2011 and ending on September 30, 2018. The remaining Term Facility principal balance of $558.0 million is due in full on November 8, 2018, subject to early mandatory prepayments. The loans outstanding under the credit facility bear interest, at our option, either: (i) at the base rate, which is defined as the highest of (a) the federal funds rate plus 0.50%, (b) the interest rate published by the Wall Street Journal as the “U.S. Prime Rate” and (c) the adjusted LIBOR rate for a one-month interest period beginning on such day plus 1.00%; provided that the base rate for loans under the Term Facility is deemed to be not less than 2.25% per annum or (ii) at the LIBOR rate plus, in each case, an applicable margin. The applicable margin is (i) in respect of the Term Facility, 2.75% per annum for borrowings based on the base rate and 3.75% per annum for borrowings based on the LIBOR rate, and (ii) in respect of the Revolving Facility, 2.50% per annum for borrowings based on the base rate and 3.50% per annum borrowings based on the LIBOR rate. The accrued interest under the Term Facility is payable quarterly beginning on February 8, 2012. As of June 30, 2012, the annual interest rate on the Term Facility was 5%. The accrued interest under the Revolving Facility is due on the last day of the quarter starting on December 31, 2011.

The Term Facility has a 1% prepayment fee in the event it is refinanced within the first year of issuance. The 2011 Facilities provide for mandatory prepayments with the net cash proceeds of certain debt issuances, equity issuances, insurance receipts,

 

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dispositions and excess cash flows. Mandatory prepayments attributable to excess cash flows will be based on our leverage ratio and will be determined at the end of each fiscal year, beginning with the year ended December 31, 2012. A leverage ratio of 1.5x or higher will trigger mandatory prepayments of 25% or 50% of excess cash flow. As of June 30, 2012, we estimated a mandatory prepayment of approximately $54.5 million to be payable in the first quarter of 2013 and reclassified this estimated prepayment amount from long-term note payable to current note payable.

The 2011 Facilities contain customary representations and warranties, affirmative and negative covenants, and events of default. The quarterly financial covenants include a maximum consolidated fixed charge coverage ratio and a minimum consolidated leverage ratio. As of and for the six months ended June 30, 2012, we were in compliance with these covenants. Further, we believe these covenants will not restrict our ability to execute our business plan.

As of June 30, 2012, our outstanding borrowings under the Term Facility were $587.2 million and accrued interest under the Facilities was $0.2 million. As of June 30, 2012, our available borrowings under the Revolving Facility were $100 million.

Discussion of Cash Flows

Cash flows from operations

Net cash provided by operating activities for the six months ended June 30, 2012 was $141.6 million, as compared to $113.9 million for the six months ended June 30, 2011. This $27.7 million increase in net cash provided by operating activities was the result of a decrease in net income of $31.8 million, an increase in non-cash adjustments of $17.8 million, and an increase in net changes in operating assets and liabilities of $41.7 million.

Net income decreased $31.8 million primarily due to a tax benefit of $42.7 million recorded in the first quarter of 2011 related to a worthless stock deduction for the common stock of Neustar NGM Services, Inc.

Non-cash adjustments increased $17.8 million due to an increase of $26.3 million in depreciation and amortization expense. This increase in non-cash adjustments was partially offset by a decrease of $4.8 million in excess tax benefits from stock option exercises, a decrease of $1.9 million in loss on sale recorded in the first quarter of 2011 attributable to the sale of certain assets liabilities of our Converged Messaging Services business, and a decrease of $1.7 million in stock-based compensation.

Net changes in operating assets and liabilities increased $41.7 million primarily due to a decrease of $62.7 million in income taxes receivable, primarily the result of the tax benefit we recorded in the first quarter of 2011 in connection with a deduction for the loss on worthless stock, a decrease of $10.1 million in prepaid expenses and other current assets, an increase of $7.8 million in deferred revenue, a net decrease of $7.6 million in notes receivable, and an increase of $4.4 million in income taxes payable. These increases in net changes in operating assets and liabilities were partially offset by a net change of $31.7 million attributable to net increases in accounts and unbilled receivables, and a decrease of $19.7 million in accounts payable and accrued expenses.

Cash flows from investing

Net cash used in investing activities for the six months ended June 30, 2012 was $22.1 million, as compared to $62.7 million for six months ended June 30, 2011. This $40.6 million decrease in net cash used in investing activities was primarily due to a decrease of $71.0 million in investment purchases, offset by a decrease of $30.9 million in cash received from the sale and maturities of investments.

Cash flows from financing

Net cash used financing activities was $16.8 million for the six months ended June 30, 2012, as compared to $37.6 million for the six months ended June 30, 2011. This $20.8 million decrease in net cash used in financing activities was primarily due to an increase of $27.6 million in proceeds from the exercise of stock options, an increase of $8.9 million in restricted cash, recorded in the first quarter of 2011, primarily used to collateralize our outstanding letters of credit, and an increase of $4.8 million in excess tax benefits from stock-based compensation. These decreases in cash used in financing activities were partially offset by an increase of $12.1 million in cash used to repurchase shares of our Class A common stock under our share repurchase programs, an increase of $8.0 million in cash used for the repurchase of restricted stock awards attributable to participants’ electing to use stock to satisfy their tax withholdings, and an increase in cash used of $3.0 million used for principal repayments on our note payable.

 

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Table of Contents

Recent Accounting Pronouncements

See Note 2 to our Unaudited Consolidated Financial Statements in Item 1 of Part 1of this report for a discussion of the effects of recent accounting pronouncements.

Off-Balance Sheet Arrangements

None.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative disclosures about our market risk, see “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Our exposure to market risk has not changed materially since December 31, 2011.

 

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of June 30, 2012, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and were operating at the reasonable assurance level.

In addition, there were no changes in our internal control over financial reporting that occurred in the second quarter of 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we are subject to claims in legal proceedings arising in the normal course of our business. We do not believe that we are party to any pending legal action that could reasonably be expected to have a material adverse effect on our business or operating results.

 

Item 1A. Risk Factors

In addition to the other information set forth in this Quarterly Report, you should carefully consider the risks discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended December 31, 2011, filed with the SEC on February 29, 2012. The risks discussed in our Annual Report on Form 10-K could materially affect our business, financial condition and future results. The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or operating results.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table is a summary of our repurchases of common stock during each of the three months in the quarter ended June 30, 2012:

 

Month

   Total
Number of
Shares
Purchased
(1)
     Average
Price Paid
per Share
     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (2)(3)
     Approximate
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans or
Programs (3)
 

April 1 through April 30, 2012

     276,742      $ 36.79        276,012      $ 151,306,346  

May 1 through May 31, 2012

     163,891        33.02        155,600        146,185,318  

June 1 through June 30, 2012

     310,756        31.28        310,200        136,481,380  
  

 

 

       

 

 

    

Total

     751,389      $ 33.69        741,812      $ 136,481,380  
  

 

 

       

 

 

    

 

(1) The number of shares purchased includes shares of common stock tendered by employees to us to satisfy the employees’ tax withholding obligations arising as a result of vesting of restricted stock grants under our stock incentive plan. We purchased these shares for their fair market value on the vesting date.
(2) The difference between the total number of shares purchased and the total number of shares purchased as part of publicly announced plans or programs is 9,577 shares, all of which relate to shares surrendered to us by employees to satisfy the employees’ tax withholding obligations arising as a result of vesting of restricted stock grants under our incentive stock plans.
(3) On July 28, 2010, we announced the adoption of a share repurchase program. The program authorizes the repurchase of up to $300 million of Class A common shares through Rule 10b5-1 programs, open market purchases, privately negotiated transactions or otherwise as market conditions warrant, at prices we deem appropriate. The program will expire in July 2013.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None.

 

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Table of Contents
Item 6. Exhibits

See exhibits listed under the Exhibit Index below.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  NeuStar, Inc.
Date: July 26, 2012   By:  

/s/ Paul S. Lalljie

  Paul S. Lalljie
  Chief Financial Officer
 

(Principal Financial and Accounting Officer

and Duly Authorized Officer)


Table of Contents

EXHIBIT INDEX

 

Exhibit

No.

  

Description

    2.1    Agreement and Plan of Merger, dated as of October 10, 2011, by and among NeuStar, Inc., Tumi Merger Sub, Inc., Targus Information Corporation and Michael M. Sullivan, as Stockholder Representative, incorporated herein by reference to Exhibit 2.1 to NeuStar’s Current Report on Form 8-K, filed October 11, 2011.
    3.1    Restated Certificate of Incorporation, incorporated herein by reference to Exhibit 3.1 to Amendment No. 7 to NeuStar’s Registration Statement on Form S-1, filed June 28, 2005 (File No. 333-123635).
    3.2    Amended and Restated Bylaws, incorporated herein by reference to Exhibit 99.1 to NeuStar’s Current Report on Form 8-K, filed June 25, 2012.
  10.22    Summary Description of Non-Management Director Compensation.†
  10.38    Form of Directors’ Restricted Stock Unit Agreement-A.†
  10.39    Form of Directors’ Restricted Stock Unit Agreement-B.†
  31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document**
101.SCH    XBRL Taxonomy Extension Schema**
101.CAL    XBRL Taxonomy Extension Calculation**
101.DEF    XBRL Taxonomy Extension Definition**
101.LAB    XBRL Taxonomy Extension Label**
101.PRE    XBRL Taxonomy Extension Presentation**

 

Compensatory Arrangement
** Pursuant to applicable securities laws and regulations, the Company is deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and is not subject to liability under any anti-fraud provisions or other liability provisions of the federal securities laws as long as the Company has made a good faith attempt to comply with the submission requirements and promptly amends the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. In addition, users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

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